Trust

During the week I attended a farewell function for a retiring colleague. The turnout was impressive, a sign of deep respect earned over a career at the bank spanning more than forty years. In the speeches, a recurring theme was trust.

The primary business of a bank is lending money, which exposes the bank to credit risk, the risk that a borrower will be unable to repay the loan. On more than one occasion, our retiring colleague had turned down a loan based on prior bad experiences with the prospective borrower. Why would you lend money to someone who has lied in the past? Learning from past betrayals of trust proved time and again to be a wise risk management strategy.

In Trust: The Social Virtues and The Creation of Prosperity, Francis Fukuyama argues that trust has played a crucial role in the development of capitalism. While some point to the role of the rule of law for enforcing contracts in enabling business, Fukuyama emphasises that legal recourse only serves as a last resort. More important is the simple confidence of a handshake: the confidence that those you do business with will live up to their end of the bargain. Those societies which developed mechanisms for extending trust beyond small networks of families and friends were rewarded with greater economic success.

If trust is important for business, it is particularly so for banking. But, scanning the financial headlines over the last few months shows a banking system apparently intent on destroying society’s trust in banks and bankers.

Barclays is just the first bank to be fined for allowing traders to manipulate the LIBOR interest rate benchmark. The scandal cost chief executive Bob Diamond his job and this story will be back in the headlines as the findings extend to other banks and civil cases unfold.

Before a US Senate hearing, HSBC’s head of compliance faced charges that the bank had acted as knowing banker to Mexican drug cartels. He acknowledged that “there have been some significant areas of failure” and resigned his position there and then.

The BBC article in the link above is coy in its language. The New York Department of Financial Services is a little less so. Page 5 of their report quotes a Standard Chartered executive as saying, “You f—ing Americans. Who are you to tell us, the rest of the world, that we‟re not going to deal with Iranians?”

The front page of the Economist epitomises where this has led.

The worldwide reputation of bankers is at its lowest point, in my lifetime at least. The result will be new and more stringent regulation and more intrusive oversight of banks by regulators. This outcome will be well-deserved as banks have proved themselves unworthy of the trust of their communities. However, it is also likely to keep borrowing costs and transaction fees high as banks struggle to deliver shareholder returns while covering the costs of new regulatory requirements. So, it will not just be banks bearing the cost of their misdeeds.

Trust is hard to earn and, once lost, harder to recover. Every bank around the world should be thinking very hard right now about how to restore trust in banks.

@pfh007: IMHO the participation of the AOFM in the Australian RMBS market is not very significant for the mortgage market itself. It has been fairly important for the RMBS market, but the majors don’t really use RMBS for funding, more for liquidity. Even then, they don’t need much of a market as they can pledge them as collateral with the RBA in need. So, the primary aim of the AOFM’s participation in the market is to keep the non-bank lenders and the regionals in the game. Perhaps ironically, the majors do very little new low doc business these days (and most of them never did non-conforming—what some refer to as “no doc”). Most of what is still done in that area is through the non-bank lenders.

@pfh007: to put it into context, the as of April last year, the AOFM had invested in $12.7b of RMBS. At that point, the mortgage market, according to RBA statistics, was around $1,021b, so the AOFM investments represented a little over 1%, a far smaller presence in the market than Fannie and Freddie in the US.

Sounds like the AOFM involvement in the RMBS since the GFC is relatively small beer – though $12.7B is about 42,000 $300k mortgages over a 4 year period so the proportion of the total market may not give a full picture.

In any event the ‘sharp practices’ alleged appear to have been pre-GFC. I suppose it would be quite remarkable if the non bank lenders had been passing on lemons to the AOFM since the GFC. That would be cheeky considering the program is designed to keep them in the market.

The 7.30 report covered the story tonight and the allegation seemed to be that all of the lenders had been involved in approving loans to unsuitable applicants. It will be interesting to see how many aggrieved borrowers appear from the woodwork and claim to have been encouraged to bite off more than they can chew.

There could be quite a few hanging on making do with bread and dripping thinking their grim situation is unique.

Funny that you guys mentioned Denise Brailey’s testimony. I’ve spent most of the day going through the whole proceedings of the Economics References Committee (08/08/2012) on the “effects of the global financial crisis on the Australian banking sector”.

Judging by what Brailey said, I think there is little reason to believe this low doc loans are all or even mostly a thing of the past.

But the whole session was interesting.

Perhaps you should give a look at the intervention of the ASIC representatives, just after Brailey’s. Senators Williams (Nationals) and Cameron (Labor) gave these two ASIC guys a really hard time.

To a certain extent, ambiguities in the current legal/institutional framework can explain what looks like lack of diligence. And the way problems were presented (through concrete cases) by Williams and Cameron made it difficult for them to answer.

But I was left with the impression (and perhaps I am being unfair) that ASIC is not particularly motivated to go to the bottom of the issues…

Muenchenberg’s testimony was interesting, too. The banks’ bosses seem intent in fighting a rearguard action against additional regulation (it seems to me, they at least in theory accept that additional regulation may be all but unavoidable).

But there was an incident, which, apart from entertaining, seems quite revealing: Cameron was harassing Meunchenberg over the latter’s rather blatant ignorance about the problems in Spain; Bushby (the chair) came gallantly to Muenchenberg’s rescue; Cameron accused the Coalition of being pro-banks and Williams, who had remained silent, feeling himself alluded, went on to mention that Cameron himself was against the inquiry.

So, if the pro-banks mob are so willing to save the banks’ asses (as illustrated by this episode), how come Labor had to be pushed into the inquiry? There’s something fishy here.

I downloaded a copy (only the first day transcript had been released when I looked this morning) but haven’t had a look at it yet. Your summary is excellent and has whet my appetite for tomorrow morning’s commute.

It would be interesting to know the circumstances behind the inquiry.

I confess to being pessimistic as to anything happening beyond some window dressing but sometimes an issue breaks out of the careful constructed narrative and takes on a life of its own. It may depend on whether house prices have been sufficiently soft for long enough to cause enough holders of half full glasses to see them as now half empty.

I am not sure that point has yet been reached. I suspect most expect interest rates may fall further and if worst came to worst the Fed Govt would offer some direct stimulus (FHOG) to keep the housing show on the road until the next election.

Actually I don’t think people see it this way at all. If anything these are just their mental tidbits of evidence supporting their much larger belief formed post GFC. That is, that the banks and insurance companies have been bailed out and that the citizens who can least afford it are paying for it. The trust is gone because they see this as a corrupted capitalist system implicating the fed, government and the banks.